ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
February 2021
TAXATION AND INCOME
DISTRIBUTION
Chapter 14
©2016 by McGraw-Hill Education Limited.
Outline for Lecture
• Measuring the progressivity of the tax system
• Tax Incidence
•
•
•
•
•
Statutory versus economic incidence of a tax
Tax incidence in competitive markets
Tax incidence in imperfectly competitive markets
Tax incidence and capitalization
Tax incidence in general equilibrium
• Empirical Incidence Studies
Background reading material: RWS Chapter 14 (ignore pages 294-298)
Empirical Incidence Studies
Tax Incidence with a Mobile Factor
Application to European soccer players
• From our theoretical
analysis, we expect that
mobile factors of
production will be very
sensitive to taxes and
bear little of the tax
burden
• Example: high ability
football/soccer players
Tax Incidence with a Mobile Factor
Application to European soccer players
Two policy changes in Europe allowed researchers to study
how taxes affect the market for top soccer players
1.
2.
The 1995 Bosman ruling lifted the cap on foreign-born players on
European club teams. This made it easier for foreign players to sign with
teams in low tax European countries
Spain’s 2004 “David Beckham rule” allowed foreign workers living in
Spain to pay a lower tax rate. All else equal, this policy made Spanish
teams more attractive for top European soccer players
Source: Kleven, Landais and Saez (2013)
Source: Kleven, Landais and Saez (2013)
Source: Kleven, Landais and Saez (2013)
Source: Kleven, Landais and Saez (2013)
Source: Kleven, Landais and Saez (2013)
Empirical Incidence Studies
Average Tax Rate, Total Taxes, by Broad Income,
Canada, 1990 to 2005
Figure 14.12
14-12
Empirical Incidence Studies
Decile Cut-offs, 1990 and 2005
(in constant 2010 dollars)
Table 14.3
14-13
Empirical Incidence Studies
Average Tax Rate, by Revenue Source, Broad Income,
Standard Case, Canada, 2005
Figure 14.13
14-14
Empirical Incidence Studies
Average Tax Rate, by Revenue Source, Broad Income,
Standard Case, Canada, 2005
Figure 14.14
14-15
Chapter 14 Summary
• Statutory incidence refers to the legal liability for a tax, while
economic incidence shows the actual sacrifice of income due to the
tax.
• Economic incidence is determined by the way price changes when a
tax is imposed; the incidence of a tax ultimately falls on individuals via
both their sources and uses of income.
• In partial equilibrium competitive models, tax incidence depends on
the elasticities of supply and demand.
• Due to capitalization, the burden of taxes may be borne by current
owners of an inelastically supplied durable commodity, such as land.
14-16
Chapter 14 Summary (cont)
• Applied incidence studies indicate the Canadian system is progressive
up to the middle of the income distribution, then modestly regressive
thereafter.
14-17
ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
February 2021
TAXATION AND INCOME
DISTRIBUTION
Chapter 14
©2016 by McGraw-Hill Education Limited.
Outline for Lecture
• Measuring the progressivity of the tax system
• Tax Incidence
•
•
•
•
•
Statutory versus economic incidence of a tax
Tax incidence in competitive markets
Tax incidence in imperfectly competitive markets
Tax incidence and capitalization
Tax incidence in general equilibrium
• Empirical Incidence Studies
Background reading material: RWS Chapter 14 (ignore pages 294-298)
Tax Incidence
Who pays taxes?
Now that we know how to measure the progressivity of the tax system
we can start thinking who actually pays taxes in Canada (or any other
country for that matter). It turns out that this is a complicated question
to answer.
Consider the following example from the textbook. Suppose that the
price of a wine bottle is $10. The government imposes a tax of $1 per
bottle sold. The tax is collected by firms as the government requires
that stores must pay $1 to the government for each bottle sold.
Who pays this tax? Three (out of many) possible scenarios.
•
•
•
The price of a wine bottle rises to $11
The price of a wine bottle stays at $10
The price of a wine bottle rises to $10.30
LO1
Tax Incidence Vocabulary
• Statutory Incidence: the party that is legally responsible for
paying the tax (firms in our wine bottle example)
• Economic Incidence: who actually pays for the tax, as
measured by the change in the distribution of private real
after-tax incomes.
• Tax Shifting: the transfer of the burden of paying the tax from
those that are legally liable for it to others due to equilibrium
price changes
• Forward shifting: the transfer of a tax burden from sellers who are legally
liable to buyers through higher prices of the taxed good
• Backward shifting: the transfer of a tax burden from buyers who are
legally liable to sellers through lower prices of the taxed good
14-6
Tax Incidence Vocabulary
• Unit tax: a tax that is a fixed dollar amount per each
unit of the good bought/sold
! =#+%
• Ad-valorem tax: a tax that is a fixed percentage of
the price of a good
! = # + = #×(1 + &)
Tax Incidence: General Remarks
• Only people can bear taxes
• Businesses (whatever their legal form) do not pay taxes. It is the owners of the
business (shareholders, partners) that pay the tax
• Taxes and the functional distribution of income
• Studies the impact of taxes on how income is distributed across different
factors of production (i.e. owners of capital, labourers, landlords)
• This analysis answers the question: does a particular tax affect owners of
capital more than labourers?
• Taxes and the size distribution of income
• Studies the impact of taxes on how income is distributed among people (i.e.
those in the top 1%,, bottom 20% etc…)
14-8
Tax Incidence: General Remarks
• Both sources and uses of income should be considered
• Consider the wine example from a few slides ago
• Suppose wine is disproportionately consumed by the poor but that the
vineyards are owned by the rich
• Ignoring the effects of taxes on the sources side when considering a
commodity tax can be misleading (same applies if ignoring the effects
on the uses side when considering a tax on an input)
• Incidence depends on how prices are determined
• Tax incidence depends on how taxes affect market prices
• How prices are determined in perfect competition is very different
from how prices are determined in a monopoly or oligopoly
• We will study both
14-9
ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
February 2021
TAXATION AND INCOME
DISTRIBUTION
Chapter 14
©2016 by McGraw-Hill Education Limited.
Outline for Lecture
• Measuring the progressivity of the tax system
• Tax Incidence
•
•
•
•
•
Statutory versus economic incidence of a tax
Tax incidence in competitive markets
Tax incidence in imperfectly competitive markets
Tax incidence and capitalization
Tax incidence in general equilibrium
• Empirical Incidence Studies
Reading material: RWS Chapter 14 (ignore pages 294-298)
Tax Incidence
Partial Equilibrium Models
• Models that look only at the market in which
the tax is imposed and ignore the ramifications
in other markets
14-5
Price per litre of wine
Unit Taxes on Commodities
Price and Quantity Before Taxation
a
Pa
Sw
u
b
P0
m
Pc
u
n
Dw
Figure 14.1
Qa
Q0
Qc
Litres of wine per year
14-6
Unit Taxes on Commodities
LO4
Price per litre of wine
Incidence of a Unit Tax Imposed on the Demand Side
Sw
Pg
P0
Pn
u
D’
Figure 14.2
Q1 Q0
Dw
w
Litres of wine per year
14-7
Unit Taxes on Commodities
LO4
Price per litre
of wine
Incidence of a Unit Tax Imposed on the Demand Side
Tax Revenue = kfhn
Price paid by
consumers
Original price
Price received
by producers
Pg
P0
Pn
k
f
m
n
Sw
Tax wedge = fh
g
h
u
D’
Figure 14.2
Q1 Q0
Dw
w
Litres of wine per year
14-8
Important Results/Concepts
Unit Taxes on Commodities
• Economic incidence does not depend on whether it
is levied on consumers or producers
• This is called the irrelevance of statutory incidence result in
public economics
• Economic incidence depends on elasticities of supply
and demand
• Elasticity of demand: !" = −
• Elasticity of supply: !0 =
% &'()*+ ,) "
% &'()*+ ,) -
% &'()*+ ,) 0
% &'()*+ ,) -
=
=−
."
.-
×
"
.0
×
.0
14-9
Unit Taxes on Commodities
LO4
Price per litre of wine
Incidence of a Unit Tax Imposed on the
Supply Side
Price paid by
consumers
Original price
Price received
by producers
S’
j
P’
u
w
Sw
Pi
gP
0
P’
n
Dw
Figure 14.3
Q’1 Q0
Q1
Litres of wine per year
14-10
Unit Taxes on Commodities
LO4
Price per litre of X
Tax Incidence when Supply is Perfectly Inelastic
SX
Pg=P0
u
Price received by suppliers
falls by the full amount of
the tax
Pn
Dx
D’x
Figure 14.4
X per year
14-11
Unit Taxes on Commodities
LO4
Price per litre of Z
Tax Incidence when Supply is Perfectly Elastic
Pg
Price paid by consumers
increases by the full
amount of the tax
u
Pn=P0
Sz
Dz
D’z
Figure 14.5
Z1
Z0
Z per year
14-12
Formula for the effect of a unit tax on
the market price paid by buyers
!ℎ#$%& '$ ( ∆(
&,
=
=
!ℎ#$%& '$ )
∆) &, + &.
The buyer bears a greater burden if the seller is more
elastic than the buyer
ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
February 2021
TAXATION AND INCOME
DISTRIBUTION
Chapter 14
©2016 by McGraw-Hill Education Limited.
Outline for Lecture
• Measuring the progressivity of the tax system
• Tax Incidence
•
•
•
•
•
Statutory versus economic incidence of a tax
Tax incidence in competitive markets
Tax incidence in imperfectly competitive markets
Tax incidence and capitalization
Tax incidence in general equilibrium
• Empirical Incidence Studies
Reading material: RWS Chapter 14 (ignore pages 294-298)
Tax Incidence
Price per unit of clothing
Ad Valorem Taxes
Ad-valorem taxes shift the perceived demand curve
down by the same proportion at all points. In this
example, the tax levied on buyers shifts perceived
demand down by 25%.
Sc
r
Pr
s
P0
m
Pm
n
Dc
Qr
Q0
Qm
Units of clothing
Figure 14.6
14-5
LO4
Ad Valorem Taxes
Price per unit of clothing
Incidence of an Ad Valorem Tax
S’c
Sc
Pg
P0
Pn
Q1 Q0
Dc
D’c
Units of clothing
Figure 14.7
14-6
Can we tell from this pay stub how
much tax Joseph Mayer paid?
Taxes on Factors of Production
• The payroll tax
• Tax on labor used to finance the Canada Pension Plan (CPP)
• In 2019, workers pay a CPP payroll tax of 5.1% of their
earnings between $3,500-$57,400
• Employers pay the same 5.1% rate for each worker
• The reason why employers and workers pay the same rate is
because politicians have long felt that the payroll tax burden
should be shared between firms and workers.
• What does our analysis of tax incidence tell us about
who “pays for” the CPP payroll tax?
14-8
LO4
Wage rate per hour
The Payroll Tax
SL
Pr
wg = w0
wn
DL
DL’
Figure 14.8
L0 = L1
Hours per year
14-9
ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
February 2021
TAXATION AND INCOME
DISTRIBUTION
Chapter 14
©2016 by McGraw-Hill Education Limited.
Outline for Lecture
• Measuring the progressivity of the tax system
• Tax Incidence
•
•
•
•
•
Statutory versus economic incidence of a tax
Tax incidence in competitive markets
Tax incidence in imperfectly competitive markets
Tax incidence and capitalization
Tax incidence in general equilibrium
• Empirical Incidence Studies
Reading material: RWS Chapter 14 (ignore pages 294-298)
Commodity Taxation with Imperfect
Competition
• Monopoly
• Despite market power a monopolist is generally made
worse off
•
•
•
•
Quantity demanded goes down
Price paid by consumers goes up
Price received by the monopolist goes down
Profits go down
• Oligopoly
• Can result in higher or lower profits
14-4
Equilibrium of a Monopolist
$
Economic
Profits
MXX
P0
ATC0
c
d
a
ATCX
b
DX
MRX
Figure 14.9
X0
X per year
14-5
Imposition of a Unit Tax on a Monopolist
$
Economic
Profits
MXX
c
P0
Economic Pn
i
Profits
dh
after unit
tax ATC0
a
f
g
ATCX
b
DX
MRX
X1 X0
MRX’
DX’
X per year
Figure 14.10
14-6
Taxes on Profits
LO5
• Economic profit: the return to the owners of a firm in
excess of the opportunity costs of the factors used in
production (also called supranormal or excess profits)
• Perfect competition
• Short run: a tax on profits doesn’t change MR or MC so output and
prices paid by consumers doesn’t change. Owners of the firm bear the
full burden of the tax
• Long run: economic profit is zero so a profit tax yields 0 revenue
• Monopoly
• The monopolist bears the whole tax. The intuition is similar to the one
for profit taxes in a perfectly competitive market in the short run
14-7
ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
February 2021
TAXATION AND INCOME
DISTRIBUTION
Chapter 14
©2016 by McGraw-Hill Education Limited.
Outline for Lecture
• Measuring the progressivity of the tax system
• Tax Incidence
•
•
•
•
•
Statutory versus economic incidence of a tax
Tax incidence in competitive markets
Tax incidence in imperfectly competitive markets
Tax incidence and capitalization
Tax incidence in general equilibrium
• Empirical Incidence Studies
Background reading material: RWS Chapter 14 (ignore pages 294-298)
Taxes on Land
• Let’s look at a tax on land. Suppose Rt is the annual
rental income on land in year t and that the market
for land is competitive
• Also assume that the land will be economically useful
for T years
• Question: What price should buyers be willing to pay
for the land?
14-4
Taxes on Land
• Question: What price should buyers be willing to pay
for the land?
$%(
$%+
$%/
!" = $%& +
+
+ ⋯+
+
1 + * (1 + *)
(1 + *)/
PR is the present value of the income the owner of the
land will receive.
14-5
Taxes on Land
Now suppose that the government announces a tax will
be imposed on land. The tax payment is u0 in year 0, u1
in year 1 and so on…
Question: what will the new price of land be?
14-6
Taxes on Land
Now suppose that the government announces a tax will
be imposed on land. The tax payment is u0 in year 0, u1
in year 1 and so on…
Question: what will the new price of land be?
!"#
$('- − *-) $('0 − *0)
$('2 −* 2 )
= $('( − *() +
+
+ ⋯+
0
1+/
(1 + /)
(1 + /)2
14-7
Tax Incidence and Capitalization
After the introduction of the tax, the price of land falls
by
!" −
!"$
= $'( +
$*+
,-.
+
$*/
(,-.)/
+ ⋯+
$*3
(,-.)3
We say that the present value of the tax liability is
capitalized into the price of the asset
Capitalization: a stream of tax liabilities becomes
incorporated into the price of an asset
14-8
ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
February 2021
TAXATION AND INCOME
DISTRIBUTION
Chapter 14
©2016 by McGraw-Hill Education Limited.
Outline for Lecture
• Measuring the progressivity of the tax system
• Tax Incidence
•
•
•
•
•
Statutory versus economic incidence of a tax
Tax incidence in competitive markets
Tax incidence in imperfectly competitive markets
Tax incidence and capitalization
Tax incidence in general equilibrium
• Empirical Incidence Studies
Background reading material: RWS Chapter 14 (ignore pages 294-298)
General Equilibrium Models
• Up to now, we have only been studying the incidence of
taxes in partial equilibrium models
• Ignoring the feedback of taxes into other markets leads to
an incomplete picture of how taxes affect incomes
• Example: suppose a tax is levied on all capital used in the
construction of housing
• Partial equilibrium: the burden of the tax is borne by suppliers and demanders
of housing capital. The most elastic party bears the smallest burden
• General equilibrium: if the tax lowers the return (i.e. incomes) of suppliers of
housing capital, they may choose instead to invest their funds in another
sector (e.g. manufacturing, natural resources). But this movement of capital
will affect prices in those other sectors. As a result, we will need to measure
how prices and the incomes of all other sectors change.
General Equilibrium Models
• There is very little good empirical evidence on the
incidence of taxes in general equilibrium. Why?
• Because tracing out the effects of taxes in all markets
depends on assumptions about
• Consumer preferences (and how they vary across people)
• How mobile/fixed factors of production are (short vs. long run
answers differ)
• Market structure (perfect competition versus imperfect
competition)
• Production technology
• Whether the model allows new goods/services to enter a market
ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
February 2021
TAXATION AND INCOME
DISTRIBUTION
Chapter 14
©2016 by McGraw-Hill Education Limited.
Outline for Lecture
• Measuring the progressivity of the tax system
• Tax Incidence
•
•
•
•
•
Statutory versus economic incidence of a tax
Tax incidence in competitive markets
Tax incidence in imperfectly competitive markets
Tax incidence and capitalization
Tax incidence in general equilibrium
• Empirical Incidence Studies
Background reading material: RWS Chapter 14 (ignore pages 294-298)
Tax Incidence
Who pays taxes?
Now that we know how to measure the progressivity of the tax system
we can start thinking who actually pays taxes in Canada (or any other
country for that matter). It turns out that this is a complicated question
to answer.
Consider the following example from the textbook. Suppose that the
price of a wine bottle is $10. The government imposes a tax of $1 per
bottle sold. The tax is collected by firms as the government requires
that stores must pay $1 to the government for each bottle sold.
Who pays this tax? Three (out of many) possible scenarios.
•
•
•
The price of a wine bottle rises to $11
The price of a wine bottle stays at $10
The price of a wine bottle rises to $10.30
LO1
Tax Incidence Vocabulary
• Statutory Incidence: the party that is legally responsible for
paying the tax (firms in our wine bottle example)
• Economic Incidence: who actually pays for the tax, as
measured by the change in the distribution of private real
after-tax incomes.
• Tax Shifting: the transfer of the burden of paying the tax from
those that are legally liable for it to others due to equilibrium
price changes
• Forward shifting: the transfer of a tax burden from sellers who are legally
liable to buyers through higher prices of the taxed good
• Backward shifting: the transfer of a tax burden from buyers who are
legally liable to sellers through lower prices of the taxed good
14-6
Tax Incidence Vocabulary
• Unit tax: a tax that is a fixed dollar amount per each
unit of the good bought/sold
! =#+%
• Ad-valorem tax: a tax that is a fixed percentage of
the price of a good
! = # + = #×(1 + &)
Tax Incidence: General Remarks
• Only people can bear taxes
• Businesses (whatever their legal form) do not pay taxes. It is the owners of the
business (shareholders, partners) that pay the tax
• Taxes and the functional distribution of income
• Studies the impact of taxes on how income is distributed across different
factors of production (i.e. owners of capital, labourers, landlords)
• This analysis answers the question: does a particular tax affect owners of
capital more than labourers?
• Taxes and the size distribution of income
• Studies the impact of taxes on how income is distributed among people (i.e.
those in the top 1%,, bottom 20% etc…)
14-8
Tax Incidence: General Remarks
• Both sources and uses of income should be considered
• Consider the wine example from a few slides ago
• Suppose wine is disproportionately consumed by the poor but that the
vineyards are owned by the rich
• Ignoring the effects of taxes on the sources side when considering a
commodity tax can be misleading (same applies if ignoring the effects
on the uses side when considering a tax on an input)
• Incidence depends on how prices are determined
• Tax incidence depends on how taxes affect market prices
• How prices are determined in perfect competition is very different
from how prices are determined in a monopoly or oligopoly
• We will study both
14-9
ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
February 2021
TAXATION AND INCOME
DISTRIBUTION
Chapter 14
©2016 by McGraw-Hill Education Limited.
Outline for Lecture
• Measuring the progressivity of the tax system
• Tax Incidence
•
•
•
•
•
Statutory versus economic incidence of a tax
Tax incidence in competitive markets
Tax incidence in imperfectly competitive markets
Tax incidence and capitalization
Tax incidence in general equilibrium
• Empirical Incidence Studies
Reading material: RWS Chapter 14 (ignore pages 294-298)
Tax Incidence
Partial Equilibrium Models
• Models that look only at the market in which
the tax is imposed and ignore the ramifications
in other markets
14-5
Price per litre of wine
Unit Taxes on Commodities
Price and Quantity Before Taxation
a
Pa
Sw
u
b
P0
m
Pc
u
n
Dw
Figure 14.1
Qa
Q0
Qc
Litres of wine per year
14-6
Unit Taxes on Commodities
LO4
Price per litre of wine
Incidence of a Unit Tax Imposed on the Demand Side
Sw
Pg
P0
Pn
u
D’
Figure 14.2
Q1 Q0
Dw
w
Litres of wine per year
14-7
Unit Taxes on Commodities
LO4
Price per litre
of wine
Incidence of a Unit Tax Imposed on the Demand Side
Tax Revenue = kfhn
Price paid by
consumers
Original price
Price received
by producers
Pg
P0
Pn
k
f
m
n
Sw
Tax wedge = fh
g
h
u
D’
Figure 14.2
Q1 Q0
Dw
w
Litres of wine per year
14-8
Important Results/Concepts
Unit Taxes on Commodities
• Economic incidence does not depend on whether it
is levied on consumers or producers
• This is called the irrelevance of statutory incidence result in
public economics
• Economic incidence depends on elasticities of supply
and demand
• Elasticity of demand: !" = −
• Elasticity of supply: !0 =
% &'()*+ ,) "
% &'()*+ ,) -
% &'()*+ ,) 0
% &'()*+ ,) -
=
=−
."
.-
×
"
.0
×
.0
14-9
Unit Taxes on Commodities
LO4
Price per litre of wine
Incidence of a Unit Tax Imposed on the
Supply Side
Price paid by
consumers
Original price
Price received
by producers
S’
j
P’
u
w
Sw
Pi
gP
0
P’
n
Dw
Figure 14.3
Q’1 Q0
Q1
Litres of wine per year
14-10
Unit Taxes on Commodities
LO4
Price per litre of X
Tax Incidence when Supply is Perfectly Inelastic
SX
Pg=P0
u
Price received by suppliers
falls by the full amount of
the tax
Pn
Dx
D’x
Figure 14.4
X per year
14-11
Unit Taxes on Commodities
LO4
Price per litre of Z
Tax Incidence when Supply is Perfectly Elastic
Pg
Price paid by consumers
increases by the full
amount of the tax
u
Pn=P0
Sz
Dz
D’z
Figure 14.5
Z1
Z0
Z per year
14-12
Formula for the effect of a unit tax on
the market price paid by buyers
!ℎ#$%& '$ ( ∆(
&,
=
=
!ℎ#$%& '$ )
∆) &, + &.
The buyer bears a greater burden if the seller is more
elastic than the buyer
ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
February 2021
TAXATION AND INCOME
DISTRIBUTION
Chapter 14
©2016 by McGraw-Hill Education Limited.
Outline for Lecture
• Measuring the progressivity of the tax system
• Tax Incidence
•
•
•
•
•
Statutory versus economic incidence of a tax
Tax incidence in competitive markets
Tax incidence in imperfectly competitive markets
Tax incidence and capitalization
Tax incidence in general equilibrium
• Empirical Incidence Studies
Reading material: RWS Chapter 14 (ignore pages 294-298)
Tax Incidence
Price per unit of clothing
Ad Valorem Taxes
Ad-valorem taxes shift the perceived demand curve
down by the same proportion at all points. In this
example, the tax levied on buyers shifts perceived
demand down by 25%.
Sc
r
Pr
s
P0
m
Pm
n
Dc
Qr
Q0
Qm
Units of clothing
Figure 14.6
14-5
LO4
Ad Valorem Taxes
Price per unit of clothing
Incidence of an Ad Valorem Tax
S’c
Sc
Pg
P0
Pn
Q1 Q0
Dc
D’c
Units of clothing
Figure 14.7
14-6
Can we tell from this pay stub how
much tax Joseph Mayer paid?
Taxes on Factors of Production
• The payroll tax
• Tax on labor used to finance the Canada Pension Plan (CPP)
• In 2019, workers pay a CPP payroll tax of 5.1% of their
earnings between $3,500-$57,400
• Employers pay the same 5.1% rate for each worker
• The reason why employers and workers pay the same rate is
because politicians have long felt that the payroll tax burden
should be shared between firms and workers.
• What does our analysis of tax incidence tell us about
who “pays for” the CPP payroll tax?
14-8
LO4
Wage rate per hour
The Payroll Tax
SL
Pr
wg = w0
wn
DL
DL’
Figure 14.8
L0 = L1
Hours per year
14-9
ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
February 2021
TAXATION AND INCOME
DISTRIBUTION
Chapter 14
©2016 by McGraw-Hill Education Limited.
Outline for Lecture
• Measuring the progressivity of the tax system
• Tax Incidence
•
•
•
•
•
Statutory versus economic incidence of a tax
Tax incidence in competitive markets
Tax incidence in imperfectly competitive markets
Tax incidence and capitalization
Tax incidence in general equilibrium
• Empirical Incidence Studies
Reading material: RWS Chapter 14 (ignore pages 294-298)
Commodity Taxation with Imperfect
Competition
• Monopoly
• Despite market power a monopolist is generally made
worse off
•
•
•
•
Quantity demanded goes down
Price paid by consumers goes up
Price received by the monopolist goes down
Profits go down
• Oligopoly
• Can result in higher or lower profits
14-4
Equilibrium of a Monopolist
$
Economic
Profits
MXX
P0
ATC0
c
d
a
ATCX
b
DX
MRX
Figure 14.9
X0
X per year
14-5
Imposition of a Unit Tax on a Monopolist
$
Economic
Profits
MXX
c
P0
Economic Pn
i
Profits
dh
after unit
tax ATC0
a
f
g
ATCX
b
DX
MRX
X1 X0
MRX’
DX’
X per year
Figure 14.10
14-6
Taxes on Profits
LO5
• Economic profit: the return to the owners of a firm in
excess of the opportunity costs of the factors used in
production (also called supranormal or excess profits)
• Perfect competition
• Short run: a tax on profits doesn’t change MR or MC so output and
prices paid by consumers doesn’t change. Owners of the firm bear the
full burden of the tax
• Long run: economic profit is zero so a profit tax yields 0 revenue
• Monopoly
• The monopolist bears the whole tax. The intuition is similar to the one
for profit taxes in a perfectly competitive market in the short run
14-7
ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
February 2021
TAXATION AND INCOME
DISTRIBUTION
Chapter 14
©2016 by McGraw-Hill Education Limited.
Outline for Lecture
• Measuring the progressivity of the tax system
• Tax Incidence
•
•
•
•
•
Statutory versus economic incidence of a tax
Tax incidence in competitive markets
Tax incidence in imperfectly competitive markets
Tax incidence and capitalization
Tax incidence in general equilibrium
• Empirical Incidence Studies
Background reading material: RWS Chapter 14 (ignore pages 294-298)
Taxes on Land
• Let’s look at a tax on land. Suppose Rt is the annual
rental income on land in year t and that the market
for land is competitive
• Also assume that the land will be economically useful
for T years
• Question: What price should buyers be willing to pay
for the land?
14-4
Taxes on Land
• Question: What price should buyers be willing to pay
for the land?
$%(
$%+
$%/
!" = $%& +
+
+ ⋯+
+
1 + * (1 + *)
(1 + *)/
PR is the present value of the income the owner of the
land will receive.
14-5
Taxes on Land
Now suppose that the government announces a tax will
be imposed on land. The tax payment is u0 in year 0, u1
in year 1 and so on…
Question: what will the new price of land be?
14-6
Taxes on Land
Now suppose that the government announces a tax will
be imposed on land. The tax payment is u0 in year 0, u1
in year 1 and so on…
Question: what will the new price of land be?
!"#
$('- − *-) $('0 − *0)
$('2 −* 2 )
= $('( − *() +
+
+ ⋯+
0
1+/
(1 + /)
(1 + /)2
14-7
Tax Incidence and Capitalization
After the introduction of the tax, the price of land falls
by
!" −
!"$
= $'( +
$*+
,-.
+
$*/
(,-.)/
+ ⋯+
$*3
(,-.)3
We say that the present value of the tax liability is
capitalized into the price of the asset
Capitalization: a stream of tax liabilities becomes
incorporated into the price of an asset
14-8
ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
January 2021
COST-BENEFIT ANALYSIS
Chapter 3
©2016 by McGraw-Hill Education Limited
Outline for Lecture
• Economic Efficiency & Distributional Considerations
• Present Value
• Public Sector Discount Rate
• Valuing Public Benefits & Costs
Background reading material: RWS Chapter 3 (up to page 52 only)
Valuing Public Benefits & Costs
LO5, LO6
Valuing Public Benefits and Costs
• Use Market Prices?
• Use Consumer Surplus?
Figure 3.2
3-5
Using Consumer Surplus to Measure
the Net Benefits of a Policy
Figure 3A.1
3-6
Valuing Public Benefits and Costs
LO7
Inferences from Economic Behavior
• How to place a value on the time saved by a
proposed project like a new highway?
• Earnings
• Other methods
• How to place a value on a life saved by a proposed
project such as a 4-lane divided highway?
• Lost earnings
• Probability of death
3-7
Valuing Public Benefits and Costs
Intangibles
• Intangibles can subvert cost-benefit exercises
• C/B tools can reveal limits on valuing intangibles
• Cost-effectiveness analysis might be best in the
presence of intangible benefits
• Comparing the costs of various alternatives that attain
similar benefits to determine which one is the cheapest
3-8
Valuing Public Benefits and Costs
LO8
Uncertainty
Project
Benefit
Probability
CE*
X
$1,000
1.00
$1,000
0
0.50
Y
$2,000
0.50
$?
*Certainty
Equivalents
(Expected Value)
3-9
Chapter 3 Summary
• Cost-Benefit analysis is the practical use of welfare economics to
evaluate potential projects.
• A project generates a potential Pareto improvement if the gainers
can compensate the losers and still enjoy a net increase in utility.
• Present value of future expected costs and benefits must be
calculated in order to allow correct comparisons.
• Although the IRR and B-C Ratio are used to evaluate projects, the
NPV criterion has fewer biases and problems.
• Choosing the discount rate is critical in cost-benefit analysis.
• In public sector analyses, three possible measures are the beforetax private rate of return, a weighted average of before- and aftertax private rates of return, and the social discount rate.
3-10
Chapter 3 Summary (cont.)
• The costs and benefits of public projects can be measured
using market prices in the absence of market failures;
otherwise, shadow prices or consumer surplus can be used.
• Quantifying the value of time and life, is necessary in
measuring benefits, but using earnings as a proxy has
limitations.
• Uncertainty of future costs and benefits can be included
through the use of certainty equivalents.
3-11
ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
January 2021
COST-BENEFIT ANALYSIS
Chapter 3
©2016 by McGraw-Hill Education Limited
Outline for Lecture
• Economic Efficiency & Distributional Considerations
• Present Value
• Public Sector Discount Rate
• Valuing Public Benefits & Costs
Background reading material: RWS Chapter 3 (up to page 52 only)
Public Sector Discount Rate
Importance of Discount
Rates/Discount Factors
• We will see how the choice of r – the discount rate –
is crucial for determining whether policies/projects
should go ahead
• Choice of r should reflect the opportunity cost of
funds: what return would the funds earn if invested
instead of the proposed project/policy
• This is much easier to do for private sector projects than public
sector projects
Private Sector Project Evaluation
LO3
Present Value Criteria
B1 - C1 B2 + C2
BT - CT
PV = B0 - C0 +
+
+ ... +
2
T
1+ r
(1 + r )
(1 + r )
Annual Net Return
Present Value
Year
R&D
Oil Well
r=
R&D
Oil Well
0
-$1,000
-$1,000
0
$150
$200
1
600
0
0.01
128
165
2
0
0
0.05
46
37
3
550
1,200
0.07
10
-21
Table 3.2
Note choice of r is critical:
•
Low r benefits Oil Well; High r benefits R&D.
3-6
Private Sector Project Evaluation
Internal Rate of Return
IRR: Discount rate that would make a project’s PV zero
B1 - C1 B2 + C2
BT - CT
PV = B0 - C0 +
+
+ ... +
=0
2
T
1+ r
(1 + r )
(1 + r )
Project
Year 0
Year 1
ρ
Profit
PV
X
-$100
$110
10%
$4
3.77
Y
-$1,000
$1,080
8%
$20
18.87
This criterion is flawed when comparing projects of much differing sizes.
Although X has the higher IRR, Y yields the higher profit.
Note that the PV criteria, using r=6%, would prefer Y.
3-7
Private Sector Project Evaluation
Benefit-Cost Ratio
B1
B2
BT
B = B0 +
+
+ ... +
2
T
1 + r (1 + r )
(1 + r )
C1
C2
CT
C = C0 +
+
+
...
+
2
T
1 + r (1 + r )
(1 + r )
Benefit-cost ratio = B/C
3-8
Problems with the Benefit-Cost Ratio
“Costs or Negative Benefits?”
Method
I
II
B
$250M
$200M
C
$100M
$100M
B/C
2.5
2.0
Suppose that $40 of costs need to be added to method I
I: Subtract
$40M from B?
$210M
$100M
2.1
$140M
1.79
OR
I: Add $40M
to C?
$250M
Benefit-Cost criterion can lead to incorrect inferences
3-9
Private Sector Project Evaluation
The Present-Value Criterion is the most reliable
evaluation guide
• Both IRR and Benefit-Cost Ratio Criteria can lead
to incorrect inferences
3-10
LO4
Public Sector Discount Rate
• Every dollar spent by the public sector comes from taxes
on the private sector
• Therefore, some argue that public sector projects should
use discount rates based on private sector returns
• There are some challenges with implementing this idea
• If funds from the private sector would have been invested, using the
private before-tax return is correct
• E.g. the government raises $1 billion in tax revenue that would have
earned a return of 5% if it was invested in the private sector
• Problem: not all tax revenue would be invested – some is consumed
• How to know how much of the revenue collected would be invested
vs. consumed?
3-11
Public Sector Discount Rate
• Social Discount Rate (SDR): the rate at which
society is willing to trade off present
consumption for future consumption
• The SDR may be different from the private
sector discount rate for several reasons
• Concern for future generations
• Paternalism
• Market Inefficiency
ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
January 2021
COST-BENEFIT ANALYSIS
Chapter 3
©2016 by McGraw-Hill Education Limited
Outline for Lecture
• Economic Efficiency & Distributional Considerations
• Present Value
• Public Sector Discount Rate
• Valuing Public Benefits & Costs
Background reading material: RWS Chapter 3 (up to page 52 only)
Present Value
Present Value
• Project evaluation usually requires comparing
costs and benefits from different time periods.
• What examples can you think of?
• The present value of a future amount of
money is the maximum amount you would be
willing to pay today for the right to receive the
money in the future.
3-5
Future Value (FV):
Projecting Present Dollars into the Future
R=$ T=years r=interest rate
How much will $100 earn in 2 years at an interest
rate of 5%?
R0 = $100
R1 = $100*(1+.05) = $105
R2 = $105*(1+0.05) = $100*(1+.05)2 = $110.25
RT = R0*(1+r)T
3-6
Present Value (PV):
LO2
Discounting Future Dollars into the Present
How much will $100 earned in 2 years at an interest
rate of 5% be worth today?
Since RT = R0*(1+r)T
Present Value
R0 = RT/(1+r)T
discount factor
discount rate
Low r – more future-oriented and benefits projects in which returns are
concentrated further into the future
High r – more present-oriented and benefits projects in which returns are
concentrated closer into the future
3-7
Present Value of a Stream of Money
R1
R2
RT
PV = R0 +
+
+
...
+
2
T
(1 + r ) (1 + r )
(1 + r )
3-8
Inflation
How to incorporate inflation – price level
increases – into the procedure?
Given: ! = inflation rate
(1 + P) R1
(1 + P) 2 R2
(1 + P) T RT
PV = R0 +
+
+...+
2
2
(1 + P)(1 + r ) (1 + P) (1 + r )
(1 + P) T (1 + r ) T
However, (1+ !) terms cancel out, leaving the PV equation from
previous slide!
CAUTION: $ values and r values must be measured consistently – if real
values are used for R, the r must be measured in real terms
3-9
ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
January 2021
COST-BENEFIT ANALYSIS
Chapter 3
©2016 by McGraw-Hill Education Limited
Outline for Lecture
• Economic Efficiency & Distributional Considerations
• Present Value
• Public Sector Discount Rate
• Valuing Public Benefits & Costs
Background reading material: RWS Chapter 3 (up to page 52 only)
Economic Efficiency &
Distributional Considerations
Cost-Benefit Analysis and Welfare
Economics
• Government intervention often creates “winners”
and “losers”
• Building a new airport or highway
• Introduction of a new tax (e.g. a carbon tax)
• Cost-benefit analysis provides a way to put a value
on the benefits to the winners and costs to the losers
to determine whether a particular policy is
worthwhile
• Closely related to Welfare Economics discussed in the previous
module
LO1
Economic Efficiency
• When resources are allocated inefficiently, then there is a
Pareto improvement available; someone can gain and no one
need lose
• If the social benefits of a project exceed the social costs,
undertaking the project increases the “size of the economic
pie”
• Beneficiaries can fully compensate the losers and still have some benefits
left over, generating a Pareto improvement
• The difference between benefits (B) and costs (C) can be
regarded as the contribution of a project to economic
efficiency
• Net Return = B − C
3-6
Efficiency of the Competitive Equilibrium
Figure 3.1
3-7
Discussion Question 1
Is a policy that creates both winners and losers a
Pareto Improvement over the status quo?
a. Yes
b. No
c. Not enough information to tell
Distributional Considerations
• Up to now we have only been discussing the evaluation
of the efficiency gains of government action (i.e. impacts
on the size of the economic pie)
• Distributional considerations refer to how the benefits
and costs of a particular government action or project
differ across people in a society
• Two issues
•
•
Compensating the losers from a policy action
Welfare weights
3-9
Distributional Considerations
Compensating losers from a policy action
• If a policy creates winners and losers, then it is not a
Pareto improvement. Does this mean the policy should not
be undertaken?
• If the policy creates a net benefit (i.e. N = B – C > 0) then in
principle it is possible for the winners to compensate the
losers so that they are not worse off
• Hicks-Kaldor Criterion: a project should be undertaken if it
has positive net present value, regardless of distributional
consequences
Distributional Considerations:
Welfare Weights
• Sometimes policy makers believe individuals in certain
groups are especially deserving and assign a higher
“welfare weight” on their gains/losses in any cost-benefit
calculation
• Groups typically defined based on income. Typically,
inequality aversion leads to more weight being put on
low-income individuals. Weights can depend on more
than income, including
– Region, the presence of young children, gender
Distributional Considerations:
Welfare Weights
• “The economist as a plumber”
• Induce policy makers to make explicit
value judgements underlying welfare
weights
• Help policy makers understand the
implications of different policy
alternatives
• Avoid letting ones own political
preferences affect advice given to
decision makers
Esther Duflo (MIT): Co-winner of the 2019
Nobel Prize in Economics
Discussion Question 2
As long as the net benefit is positive, the gainers from a
policy can agree to compensate losers and still enjoy an
increase in utility. This notion is called
a.
b.
c.
d.
a potential Pareto improvement
the Hicks-Kaldor criterion
both of the above are correct
none of the above are correct
ECON 3C03
Public Sector Economics: Taxation
Adam M. Lavecchia
Department of Economics
McMaster University
January 2021
Fundamentals of
Welfare Economics
Chapter 2
©2016 by McGraw-Hill Education Limited.
Outline for Lecture
•
Introduction to Welfare Economics
•
Introduction to Pareto Efficiency
•
Theory
• Pure exchange economy
• Economy with production
•
First Welfare Theorem
•
Second Welfare Theorem
•
Equity-Efficiency Tradeoffs
•
Individual Failures
Market Failures
LO6, LO7
Causes of Inefficiency
• Market Power
• Monopoly
• Nonexistence of Markets
• Asymmetric information
• Externality
• Public good
2-4
Individual Failures
Individual Failures
• Like market failures, the presence of individual failures
can always lead to a failure of the FWT
• Individual failures: arise when individuals are not “fully
rational”. Some examples include:
• Inattention
• Time-inconsistency (procrastination)
• Preferences that depend on one’s group/identity
Chapter 2 Summary
• Welfare economics is the study of the desirability of different
economic states.
• Pareto efficiency occurs when no person can be made better off
without making another person worse off.
• MRSixy = MRTxy i=persons i….n
• First Fundamental Theory of Welfare Economics: under certain
conditions, competitive markets result in Pareto efficiency.
• Second Fundamental Theory of Welfare Economics: Society can
attain any Pareto Efficient outcome by making a suitable assignment
of initial endowments and free trade.
2-7
Chapter 2 Summary (cont)
• A social welfare function summarizes society’s preferences
concerning the utility of each of its members and it may be used to
find the allocation of resources that maximizes social welfare.
• A possible justification for government intervention is market failure,
which may occur in the presence of market power or when some
markets do not exist.
• The fact that the market does not allocate resources perfectly does
not necessarily mean that the government can do better.
• Welfare economics provides a coherent and useful framework for
analyzing policy, but is controversial does not pay much attention to
the processes used to achieve results.
2-8
HUMAN RESOURCE MANAGER JOB ANALYSIS
Human Resource Manager Job Analysis
O*NET1 and Meyer2
1
2
Human Resource Manager Summary Report
Apple Inc.’s Organizational Culture & Its Characteristics
1
HUMAN RESOURCE MANAGER JOB ANALYSIS
2
Human Resource Manager Job Analysis
As previously mentioned, there are several sectors in which Industrial and Organizational
(I/O) psychologists can work. While Industrial-Organizational Psychology is a key specialty in
improving workflow and productivity, it has found massive application in sectors such as
academia, government, industry and consulting. Nonetheless, one of the occupations which
persons in Industrial-Organizational Psychology can venture into is becoming a human resource
manager. A human resource manager leads and directs routine duties in the human resource
department. The major responsibilities of a human resource manager include developing and
implementing HR strategies and initiatives, managing recruitment and selection processes and
reporting to the top management about the HR department.
Job Classification
The human resource manager occupation is usually classified under “job zone four” since
“considerable preparation is required.”. In terms of the educational requirements, a four-year
bachelor's degree and several years of experience are required (O*NET, 2020). According to
O*NET, “the occupational code of a human resource manager job is 11-3121.00”. They also
state that some of the task requirements of human resource managers include “[serving] as a link
between management and employees”. To link the two groups, human resource managers need
to constantly handle any arising questions, interpret information to each and help resolve workrelated problems that any of the parties may experience (O*NET, 2020). Another task
requirement is “advising managers on organizational policy matters.” They need to ensure that
the interest of employees is taken into account when making these policies (O*NET, 2020). In
addition to this, human resource managers also have a task to “analyze and modify compensation
and benefits policies” to ensure that they are “competitive programs” and that they comply with
HUMAN RESOURCE MANAGER JOB ANALYSIS
3
the law (O*NET, 2020). Most importantly, human resource managers are also required to
“perform other difficult staffing duties,” especially when an organization is understaffed, there
are employee disputes and when firing and disciplinary actions need to be done. Another task
requirement of the latter occupation is to respond and defend organizations when their personnel
are sued and during investigations (O*NET, 2020).
Description of the Knowledge, Skills and Abilities
To effectively execute the above tasks, human resource managers are required to have
“knowledge in personnel and human resources” as well as in “administration and management”
since they deal with employees directly and will be their leaders and managers (O*NET, 2020).
Besides this, knowledge of the “English language, law and government” is important since they
need to use good English to effectively communicate with employees and managers and
understand law and government to avoid lawsuits. Most importantly, “knowledge in education
and training” matters is important. Besides this, human resource managers are also required to
have skills such as “active listening, speaking, management of personnel resources, judgment
and decision making and reading comprehension” (O*NET, 2020). These will help them
dispense their duties and interact with others. In addition to these basic skills, technology skills
necessary to deal with “accounting, document management, enterprise resource planning, human
resources and time accounting software” are also needed. On the other hand, human resource
managers are required to have abilities such as “oral comprehension, oral expression, written
comprehension, deductive reasoning and speech clarity” (O*NET, 2020).
HUMAN RESOURCE MANAGER JOB ANALYSIS
4
Description of the Work Environment
Human resource managers mostly work in offices which in most cases have closed
designs. Some of the supervisory controls that human resource managers are subjected to include
quarterly reports and audits which help the senior management track performance and also
resource use. Common physical demands as a human resource manager include continuous
sitting, use of fingers to feel and handle things, reaching out things using hands, talking to others,
occasional incidences of standing and walking and finally lifting and moving small weights of up
to 10 pounds. In most workplaces, human resource managers have high interpersonal contact
and teamwork with employees and the rest of the management as evident from the work context.
The human resource manager's work is averagely complex, while supervision in this position is
limited (O*NET, 2020).
Apple’s Organizational Culture and Competitive Environment
One of the organizations in which one could work as a human resource manager is Apple.
Apple's organizational culture is characterized by creativity and innovativeness (Meyer, 2019).
At Apple, employees are encouraged to become creative and innovative to produce “top-notch”
and value-adding products in the market. Apart from this, working under pressure to meet
deadlines is another aspect of Apple's organizational culture. Typically, employees are assigned
projects and given deadlines that they must deliver on time to get rewards. Despite being under
pressure, employees have the autonomy to make their own decisions. Further, diversity and
inclusivity are the other characteristics of Apple's organizational culture (Meyer, 2019). At
Apple, the company believes that diversity brings about innovativeness and therefore, persons
from different backgrounds, professions and with different abilities are involved in projects.
Further, secrecy is also key at Apple. Apple's competitive environment is quite dynamic as it
HUMAN RESOURCE MANAGER JOB ANALYSIS
5
deals with technological gadgets. To avoid the spilling of production secrets to competitors,
employees are required to observe high secrecy within the company (Meyer, 2019).
Lastly, Apple’s environment is very competitive as there exist many huge and small
companies. Every day, new competitors of Apple enter the market with more innovative
products while existing competitors such as Samsung, Nokia, Dell, Microsoft and HP continue to
innovate better products (Meyer, 2019). All, in all, Apple is one of the best organizations in
which one could work as a human resource manager and thus it is important to keep watch of its
human resource management occupations as they probably hire externally to bring about new
knowledge.
HUMAN RESOURCE MANAGER JOB ANALYSIS
6
References
Meyer, P. (2019, February 15). Apple Inc.’s Organizational Culture & Its Characteristics (An
Analysis). Retrieved from http://panmore.com/apple-inc-organizational-culture-featuresimplications#:~:text=Apple%20Inc.%20has%20an%20organizational,that%20challenges
%20conventions%20and%20standards
O*NET. (2020, November 17). 11-3121.00 - Human resources managers. Retrieved from
https://www.onetonline.org/link/summary/11-3121.00
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